Conventional Wisdom is so often proved wrong. Thinking back over my career, it's amazing how many times what is believed true without a doubt in the markets turns out completely erroneous. There's no mystery behind this phenomenon. Responsibility lies foremost in flawed analytical frameworks. Fundamentally, bull market psychology rests on the basic premise that underlying fundamentals are sound - economic growth, earnings, inflation dynamics, new technologies, global trade, etc. No need to look further or dig any deeper.

When securities markets are strong (inflating), it's taken as a given that the financial system is robust. The problem, however, is that the underlying finance fueling the recent bull market has been patently unsound - and has been so for three decades of recurring boom and bust cycles.

A wise person said that it's not true that we don't learn from history. It's that our learning is dominated by recent history. It becomes too easy to ignore everything beyond the past few years. Over a relatively short time horizon, the previous bust cycle becomes ancient history.

What matters for the markets - especially as the cycle evolves to the speculative phase - is the here and now. It's assumed that everyone acquired understanding and insight from the crisis experience - especially policymakers. They'll ensure there is no repeat; they have the tools and have amassed experience and comfort employing them. The previous crisis was a "100-year flood." Good not to have to ponder a recurrence for a few generations.

Conventional Wisdom will look especially foolish when this protracted cycle comes to its fateful conclusion. Not only was the mortgage finance Bubble not the proverbial "100-year flood," it set the stage for historic global government finance Bubble excesses. The real once-in-a-lifetime crisis lies in wait. Not only do we not learn from our mistakes, we instead seem to go out of our way to create bigger ones. This time much Bigger. This predicament was on full display this week.

April 26 - CNBC (Jeff Cox): "The $21 trillion debt the U.S. has amassed on its balance sheet isn't weighing on the minds of credit rating agencies. Moody's and Fitch in recent days have reaffirmed the nation's top-notch credit standing, reasoning that even with the massive pile of IOUs, the nation has sufficient resources to keep its standing. 'The affirmation of the US' Aaa rating reflects the US' exceptional economic strength, the very high strength of its institutions and its very low exposure to credit-related shocks given the unique and central roles of the US dollar and US Treasury bond market in the global financial system,' Moody's analysts said in a report…"

I tended to cut the rating agencies some slack after the mortgage finance Bubble collapse.

Clearly, their models were deeply flawed, and they allowed financial interests to sway their judgement and outlook (during a lavish boom, who doesn't?) In general, it becomes quite a challenge to accurately assess underlying Credit quality while the system is in the throes of such an extended self-reinforcing Credit boom. Clearly, the Credit rating agencies hold some responsibility for what in hindsight was atrocious ratings blunders throughout the mortgage universe. Yet when compared to Fed policies, the GSEs and Wall Street finance, the ratings companies were in the crisis causing minor leagues.

I'll assume that the rating agencies received the message loud and clear: Don't mess with the Uncle Sam's "AAA." If the U.S. Credit standing is today "top notch," then we've reached the point of an incredibly extended Credit cycle where top notch basically means nothing. Our government is amassing debt and obligations it will not repay. There's the $21 TN of rapidly expanding debt, along with tens of Trillions of future entitlements. And let's not forget the government-sponsored enterprises. The GSEs ended 2017 with a record $8.857 TN of securities outstanding (record assets of $6.826 TN, along with a record $2.125 TN of guaranteed MBS).

April 25 - Financial Times (Alistair Gray): "From the spotted bronze pumpkin in the valet court to the light sculpture above the marble concierge desk, few expenses have been spared at Sky Residences. Residents of the glistening 71-storey tower in Manhattan's Hell's Kitchen have access to a basketball court, a private art collection and a billiards lounge. The luxury lifestyle does not come cheap: one-bedroom apartments are on the rental market for as much as $6,500 a month. High-earning New York professionals who live in the building take the rents in their stride, though they may be surprised to discover who financed it. Last summer, Freddie Mac, the home loans guarantor propped up by US taxpayers a decade ago after the subprime housing crisis, backed by a $550m loan to the building's owners - Moinian Group, among New York's largest private landlords, and SL Green Realty… It was the latest in a series of deals to support top-end commercial property developments by Freddie Mac and its counterpart Fannie Mae… By the end of last year the pair had a financial interest in almost $500bn of commercial mortgages, equivalent to 38% of the total outstanding across the US. That compares with almost $200bn, or 25% of the market, a decade ago."

Did we learn nothing? GSE Securities ended 2008 at a then record $8.167 TN. Remember all the talk of GSE reform - and possibly even winding down the (insolvent) behemoth agencies?

Not going to happen. Outstanding GSE Securities did decline to $7.560 TN by the end 2012.

Then a funny thing happened along the path of reformation: GSE Securities expanded $238 billion in 2013, $150 billion in 2014, $221 billion in 2015, $352 billion in 2016 and another $337 billion in 2017. It adds up to GSE growth of about $1.3 TN in five years, as the GSEs once again become willing boom-time instigators. It's worth adding that Fannie Mae increased "Total MBS and Other Guarantees" by about $23.5 billion during the first two months of 2018, with Freddie Mac's up $16.4 billion in three months.

For years, I argued that the thinly capitalized GSEs were destined for failure. It's not clear what I should be arguing these days. Their position is even more precarious, but no one could care less. The GSEs have become only bigger and have essentially no capital buffer - remitting earnings to their guardian, the U.S. Treasury. I suggest the ratings agencies ponder the trajectory of U.S. deficits in the event of a financial crisis and economic downturn. On top of exploding traditional deficits, taxpayers (more accurately, future generations) will be on the hook (again) for what will surely be massive recurring losses at the government-sponsored enterprises. A yield spike and the party marathon is over.

If big tech revenue growth is not clear enough indication of a boom, I'm not sure where else to point. Indeed, it's reached multiples of the late-nineties technology Arms Race. This degree of growth concurrent with three-month T-bills at only 1.75% indicates finance remains much too loose. And while mortgage borrowing costs have been rising modestly, housing data confirm that rates remain artificially low for this key economic sector as well. I would argue excesses at the upper-end of housing markets nationally exceed those from the mortgage financial Bubble period.

April 25 - Bloomberg (Vince Golle): "The U.S. housing market's storyline for the last several years has been one of steady demand and limited supply, pushing prices ever higher. Now, a new chapter has opened up for the industry and its customers: soaring costs for building materials. Reports on Tuesday underscored both resilient purchase activity and accelerating home prices.

The S&P CoreLogic Case-Shiller index showed property values in 20 major U.S. cities climbed 6.8% in February, the biggest year-over-year gain since June 2014. Government data revealed a faster-than-projected rate of new-home sales in March and huge upward revisions to the prior two months. Inventories of previously owned homes are plumbing the lowest levels in at least 19 years, a key reason why resilient demand by itself has fueled price appreciation that's extending to the new-homes market. Now, with the costs of lumber and other building materials soaring together, buyers are unlikely to see any relief for some time."

April 24 - Bloomberg (Katia Dmitrieva): "Sales of previously owned U.S. homes rose to a four-month high as buyers, fueled by a solid job market and tax cuts, quickly snapped up the limited number of available properties, National Association of Realtors data showed… Inventory of available properties fell 7.2% y/y to 1.67m, lowest for March in data back to 1999…"Early in the mortgage finance Bubble, Conventional Wisdom held that home prices were supported by the limited availability of buildable lots across much of the country. Few anticipated the building boom that was to unfold over subsequent years. It just took the homebuilders some time to get situated. By 2003, housing starts exceeded two million units, the strongest level since the seventies.

I was reminded of this dynamic with last week's release of stronger-than-expect March Housing Starts and Permits data. Building Permits were at the highest level since July 2007, with Starts near the high going back to 2007. And then there was this week's reports on Transactions, Prices and Inventories. Case-Shiller had y-o-y price gains up 6.8% vs. estimates of 6.35%. After stabilizing somewhat in 2017, home price gains have accelerated.

February New Home Sales, at 694,000 (annualized), crushed estimates of 630,000. There was also a significant upward revision to January sales. New Home Sales are running at about the highest level since 2007. March Existing Home Sales (5.60 million annualized) were somewhat above estimates, also near highs since 2007. While up for the month (and somewhat above recent historic lows), the 1.67 million available inventory was down 7.2% y-o-y. At 3.6 months, meager home inventories are below levels from the mortgage finance Bubble era. Weekly mortgage purchase applications were 11% above the year ago level.

Ten-year Treasury yields traded to 3.03% in Wednesday trading, before settling back down to end the week little changed at 2.96%. During Wednesday's session, benchmark MBS yields rose to 3.74%, at that point up eight bps for the week to the highest yield since July 2011.

At least at this point, I'm skeptical. Home price inflation continues to run significantly above after-tax mortgage borrowing costs - and is accelerating. There is likely decent pent-up home purchase demand - and a surge of increasingly anxious buyers cannot be ruled out.

The narrative over recent years - really, since the financial crisis - has been that inflation is no longer an issue. From the standpoint of monetary policy and, accordingly, for financial markets, inflation has been thoroughly suppressed: global overcapacity and wage stagnation have from a secular standpoint quashed inflationary pressures. It would seem time for Conventional Wisdom to start wising up.

I tend to believe that so-called "globalization" has been misunderstood from a global inflation perspective. Conventional thinking has it that the globalization of manufacturing, trade and finance will permanently contain inflationary pressures. But in the U.S. and elsewhere, there is a populist backlash against the loss of manufacturing and higher paying jobs to cheap imports. The rise of tariffs, protectionism and fair trade sentiments would seem to mark an important juncture for "globalization's" headlock on inflation.

The aggressive U.S. stance with trade comes, not coincidently, with an aggressive posture toward fiscal policy. It's the type of policy mix one might expect at the trough of the economic cycle. But nearing the 10-year anniversary of crisis onset? It may have taken longer than normal, but when it comes to inflation prospects we're witnessing a plethora of typical late-cycle characteristics and developments.

There is mounting evidence that wage growth has attained sustainable momentum. This dynamic should work over time to broaden inflationary pressures. Rising compensation comes as energy prices gain momentum, while import prices more generally risk surprising to the upside. Moreover, I believe housing has begun to demonstrate an increasingly vigorous inflationary bias. With notable gains in construction and sales transactions, rising prices and inflating home equity, the surprise going forward could be a meaningful jump in mortgage borrowings.

If a few pieces fall into place, before you know it we'll have settled into an inflationary backdrop that looks a lot more normal than this deflated "r star" the Fed and economics community have been enchanted with over recent years. Conventional Wisdom that additional years of Fed accommodation will be required to sustain a 2.0% inflation target falls flat on its face. From my perspective, there are reasonable scenarios where a so-called "neutral" Fed funds rate of 4%, 5%, or perhaps even 6%, no longer seem unthinkable.

The other side of the story: there's a serious global Bubble that risks bursting in spectacular fashion: Fragility in China, economic stagnation in Europe and vulnerabilities throughout EM. I'll assume global fragilities go a long way in explaining 3% Treasury yields in the face of percolating U.S. inflationary pressures.

Conventional Wisdom holds that a flat yield curve indicates elevated recession risk. Some on the FOMC have cited the flatting curve as justification for proceeding cautiously with rate normalization. I would counter that 10-year Treasury yields remain low specifically because of global Bubble risk. The bond market discerns the likelihood that the Fed will at some point reverse course, moving to slash rates and redeploy bond purchases (QE). There is, as well, ongoing QE from the European Central Bank and Bank of Japan. Global bonds were supported this week from dovish indications from both central banks.

Developed bond markets were also likely supported by instability that seems to have afflicted EM currencies. The resurgent U.S. dollar came at the expense of the Polish zloty (down 2.1%), the Chilean peso (down 2.0%), the Hungarian forint (down 1.9%), the South African rand (down 1.8%), the Czech koruna (down 1.7%), the Argentine peso (down 1.7%), and the Colombian peso (down 1.6%). EM bonds were under additional pressure this week.

The dollar short and EM long are two prominent Crowded Trades. That both are currently moving against the Crowd adds credence to the incipient global de-risking/de-leveraging thesis. Unfolding pressure on global "carry trade" leverage? And it was another wild week in big tech. The Nasdaq100 traded as high as 6,721 during Monday trading, dropped as low as 6,427 by Wednesday, opened Friday trading at 6,750 before ending the week at 6,656. The VIX almost made it back to 20 Wednesday, before closing the week at 15.41.

I don't see a VIX with a 15-handle doing justice to current stock market risk. Wednesday, in particular, had that unsettling dynamic of concurrent pressure on equities, Treasuries, corporate Credit and EM. On the other hand, if risk markets somehow turn quiescent, I would expect the bond market's focus to rather swiftly shift back to supply and mounting inflation risk.

SHALOM OUANOUNOU was declared dead in September. The 25-year-old Canadian had suffered an asthma attack so severe that he was taken to hospital in Ontario where he was put on a ventilator. After carrying out tests, doctors found that his brain lacked functions such as consciousness and respiratory reflexes. They issued a death certificate and prepared to disconnect the medical equipment.But Mr Ouanounou’s family said that he and they, as Orthodox Jews, believe that life ends only when breath and heartbeat cease. They won a court injunction to keep him on artificial ventilation; his heart stopped of its own accord in March, five months later. “It just doesn’t make any sense to us to say he wasn’t alive throughout that period,” says Max Ouanounou, his father.Mr Ouanounou would have been declared dead in the same way in almost all rich countries. They tend to treat irreversible loss of all of the brain’s function as constituting death. American states typically demand evidence that the whole brain has stopped working, for example a lack of intracranial blood flow, but there is no national protocol. Britain requires only the death of the brainstem, which runs between the spinal cord and the rest of the brain, and regulates reflexes and functions such as breathing. (Advocates for using brainstem death say it is a proxy for whole-brain death, though others disagree.)In practice, the question of when someone is dead rarely arises. The heart and lungs usually shut down around the same time as the brain. The lack of pulse and breath is generally considered a biological marker for brain death, not an alternative to it. But determining when death occurs might matter for all sorts of reasons: when is someone widowed? When should a company pay out life insurance? Even, when should a new president be sworn in? As Lainie Ross, a doctor and bioethicist at the University of Chicago, says: “We can’t have someone being considered dead by some people and alive by others.”Cases such as Mr Ouanounou’s are challenging the consensus about what it means to be dead. A court in Ontario will decide whether to revoke his original death certificate and issue another showing him as having passed away this year. “Death is a value judgment based on cultural, philosophical, religious, social and other considerations,” says Rihito Kimura, a Japanese lawyer and bioethicist. That makes it subject to change.What it means to be dead was long considered simple; a lack of pulse and breath was the standard sign. But that changed in the 1950s and 1960s with advances in modern medicine. Machines could, for the first time, keep pumping blood through a person’s arteries and veins, and aerating their lungs, long after they lost the ability to do so themselves. That lengthened the dying process: no longer must all organs shut down around the same time.In 1968 a committee at Harvard Medical School recommended that brain death be the standard definition, and came up with criteria for assessing it. In 1981 America drew on this report in the Uniform Determination of Death Act, which suggests states use brain death as the definition, and that it can be determined either by the end of the heartbeat and breath, or by permanent damage to the whole brain. Most Western countries followed suit.Mind over matterThere are three reasons why policymakers and most doctors have focused on the brain. One is that Western philosophy sees a distinction between mind and body. And while in other cultures the heart is often viewed as the central organ, Western societies emphasise the importance of the mind, for which the brain is used as a proxy. Bioethicists argue that using brain death as the standard definition values what is unique about humans.The second consideration is the cost of keeping a person on life support. Stretched health services do not want to spend money on what some consider to be “aerating corpses”. The hospital treating Mr Ouanounou reckoned it had, at the time of the injunction, spent C$500,000 ($400,000) on his treatment.The final reason is to facilitate organ transplants. In Britain 1,332 people died in 2016 due to a lack of an organ donor; in America the figure is more than 7,000 (the two countries measure the tally in different ways). More organs can be used from a donor who is dead according to brain criteria than after cardio-respiratory failure.In some countries it is openly recognised that a shortage of organs is a consideration in the use of brain death. This stokes fears that people will be determined brain-dead so that their kidneys, liver or heart can be used in a transplant operation. It also helps explain why Japan continues to rely on cardio-respiratory death, says Mr Kimura. In a famous case in 1968 a doctor in Sapporo, on the northernmost island of Hokkaido, carried out one of the world’s first heart transplants. It was applauded until some questioned whether the donor had been pronounced brain-dead prematurely.Facing a severe shortage of organs, Japan in 1997 tried to find a middle ground by enacting a law allowing those who clearly express their wish to be a donor to be declared dead when their brains shut down. India’s organ-transplant law of 1994 specifies that death can be determined by a dead brainstem. But that has caused confusion about how to define the death of non-donors, notes Sunil Shroff of the Mohan Foundation, an NGO that promotes organ donation. Other laws dealing with death refer to it as the end of all evidence of life. It is not clear whether that means the brainstem or something broader.A problem with using whole-brain death as the definition is that it is increasingly apparent that many people declared dead on this basis do not show the permanent cessation of functioning of every aspect of the brain, says Dr Ross. The hypothalamus may continue to secrete hormones, for example. That is one of the arguments being made in the case of Jahi McMath, a bubbly American teenager until a simple operation went wrong. Her family dispute the hospital’s assessment, made in 2013, that she is brain-dead, pointing to the fact she is menstruating, which is neurologically regulated.Other critics of the status quo support the principle of using the brain-death standard, but worry about how it is applied. They point out that it can leave doctors a lot of room for interpretation. Defenders of the use of brain-death criteria retort that such problems can usually be resolved. Countries can clearly define death in law, in line with medicine’s ability to diagnose it, so there is less room for abuse or doctors’ personal judgments.But the fundamental challenges to the definition are about whether the brain should be the key component of death. Often this is down to religious belief. Unlike in the past, when Jews were declared dead by a rabbi who would use a feather or mirror to detect when the final breath had left the body, today most Jews accept brain death. But Orthodox sects consider this wrong. Some Muslims hold similar beliefs. Another current case in Canada turns in part on the Christian beliefs of Taquisha McKitty, who was declared dead last year after a drug overdose. Her family say that she believes that the soul is present so long as the heart works and she is breathing, even if only due to medical equipment.Hugh Scher, the lawyer for the families of both Mr Ouanounou and Ms McKitty, argues that Canada’s legal definition of death violates its constitutional guarantee of freedom of religion. (His opponents say that only living people have that right.) The idea has found some support. The American state of New Jersey bans a doctor from declaring someone dead from irreversible brain damage if the medic has reason to believe it would contravene the patient’s religious convictions. In 2008 Israel introduced a brain-death standard but still allows some choice for patients between that definition and using a cardio-respiratory one.Last wishesMany developing countries continue to use cardio-respiratory definitions. African traditional faiths often make people want to prolong life at all costs, observes Rabi Ilemona Ekore, a doctor at the University of Ibadan in Nigeria. Many Africans believe they will become an ancestor in the spirit world only if their life is not cut short.

Objections to brain death are not just religious, though. Some places prefer cardio-respiratory death because they lack the medical equipment to keep a brain-dead person breathing, notes Daphne Ngunjiri, a Kenyan doctor.

Japan is reluctant to see the brain-dead as gone partly owing to a different notion of what makes someone human. The whole body is given prominence in Japan, rather than the mind, as in the West. “If we explain to families the notion of death in Western countries, they struggle to accept it,” says Misa Ganse of the Japan Organ Transplant Network.Opinion polls tend to show that people do not understand brain death, but when they do, the results suggest that even in Japan a majority supports the idea of using it as the standard. But Claire White-Kravette, a psychologist at California State University, Northridge, in Los Angeles, says that even if people accept it in the abstract or at an intellectual level, when it involves an actual person, they feel differently.It is hard for people to accept that someone is dead when faced with a relative who is warm and rosy-cheeked. Mr Ouanounou, for example, says his son looked “like he was sleeping”. Ms White-Kravette also reckons that most surveys ask about the mind and body only, thereby failing to allow for a third component, call it life-force or a person’s essence, which many people, whatever the country, believe exists, and do not necessarily associate with the brain. Such objections are not catered for, bar in New York state, which directs doctors to show “reasonable accommodation” for not only religious but also moral protests against the brain-death standard.The challenges to the status quo have a unifying theme: the lack of say over something as fundamental as one’s own demise. Blanket definitions of any sort go against what Rob Jonquière of the World Federation of Right to Die Societies, a network spanning 26 countries, says is a global trend towards more respect for people’s right to determine their own end. Few dispute that, for society to function, death must be clearly defined. But there are growing calls for countries to allow people to opt out of their national definition—within limits—by making their wishes known.Dr Ross and Robert Veatch, a professor at Georgetown University, argue that those options should include not only cardio-respiratory death, but a more liberal definition of brain death based on the irreversible loss of consciousness. Assuming it is medically possible to determine this, they contend that it is what makes us human and what current brain-death definitions attempt, clumsily, to measure.Allowing people some discretion in death would have practical implications. But none seems insurmountable. Insurance premiums could, for example, take account of medical charges to cover the costs of equipment and drugs for someone who favours cardio-respiratory death. The limited examples in Japan, Israel and parts of America have thrown up few problems. Societies find ways to deal with similarly tricky matters. Even when less is at stake.

The US republic is under threat, according to Donald Trump: “It is an attack on what we all stand for,” he warned. America’s president was not referring to Bashar al-Assad’s alleged use of chemical weapons, nor Russian assassinations. He meant last week’s federal raid on Michael Cohen, his personal lawyer — and keeper of his secrets. American values are equivalent to Mr Cohen’s legal immunity, according to Mr Trump. That is how the president’s mind works.It is quite different to how a legal brain works. Investigators now possess ten boxes of Mr Cohen’s documents and have downloaded the contents of his devices. A judge has upheld their right to break Mr Trump’s attorney-client privilege, which requires a high evidential bar. In the case of a sitting US president, it is unusually high. Mr Cohen cleared it with distinction.By his own admission, Mr Cohen “would do just about anything” for Mr Trump. That involves paying off porn stars with whom the president has allegedly had affairs. It has also included acting as Mr Trump’s business go-between in Russia and eastern Europe. He dabbles in valuable New York taxi medallions, too. Mr Cohen is the Trump family fixer who is also a lawyer. Fans of The Godfather will recognise a coarser version of Tom Hagen.There is no mystery why Mr Trump is so worried. Mr Cohen joins the growing list of close Trump associates under interrogation. Given his business dealings, he may well join Mike Flynn, Mr Trump’s first national security adviser, and Rick Gates, a former campaign official, in cutting a deal with the investigators. Either that or risk many years in jail.Each time the net tightens, Mr Trump reaches for the proverbial nuclear button. His target is Rod Rosenstein, the deputy attorney-general, who approved the raid on Mr Cohen’s office. Mr Rosenstein also appointed Robert Mueller as special counsel. The fastest way to fire Mr Mueller would be to first replace Mr Rosenstein. Twice before Mr Trump has tried to sack the special counsel. In each case he was talked out of it. Eventually, he is likely to get his way.Which brings us back to the attack on the American republic. The danger comes from Mr Trump. In his newly published memoir, James Comey, the former FBI director who was fired by Mr Trump, talks about the president’s Cosa Nostra values. Mr Comey’s dealings with Mr Trump reminded him of the New York mafia families that he prosecuted in the 1980s: “The silent circle of assent. The boss in complete control. Loyalty oaths. The us-versus-them world view. The lying about all things, large and small, in service to some code of loyalty.”It is this code that has stopped Mr Trump from staffing his administration. Too many potential officials have signed “Never Trump” letters, or criticised Mr Trump in public. In Mr Trump’s world — as in the mafia — disloyalty is the unforgivable sin. That is why the ranks of his administration keep thinning. Mr Trump has enmeshed most of the Republican party in that code. Senior Republicans no longer dare criticise him. On Monday, Jim Jordan, former chairman of the powerful Republican Freedom Caucus, refused to admit Mr Trump has ever done anything wrong. Asked repeatedly if he had ever heard Mr Trump lie, he said: “I have not.”If things go well for the US republic, such spinelessness will become the epitaph of many politicians. Faced with a choice between loyalty and honesty, Republican leaders have chosen loyalty at any cost. That bill keeps mounting. Last week, Paul Ryan, the Speaker of the House of Representatives, said he would not run again. Many hoped Mr Ryan was giving himself room to do the right thing. Since he no longer faced re-election, he could now hold Mr Trump to account. That is unlikely. Like anyone who does business with Mr Trump, Mr Ryan has devalued his moral standing. The more you cover up for the head of the family, the harder it is to escape. There is no witness protection programme for politicians.The bigger tests are still to come. Mr Mueller has yet to take action on the Democratic email hacking; on the conflicts of interest of Jared Kushner, the president’s son-in-law; and on the Trump campaign’s alleged co-ordination with WikiLeaks. Each of these poses dangers. Mr Mueller is made of sterner stuff than most. According to Mr Comey, when the special counsel had a knee operation a few years ago, he turned down anaesthesia in favour of biting on a leather belt. The US republic will need more such mettle for what lies ahead.

INTEREST rates are heading higher and that is likely to put financial markets under strain. Investors and regulators would both dearly love to know where the next crisis will come from. What is the most likely culprit?Financial crises tend to involve one or more of these three ingredients: excessive borrowing, concentrated bets, and a mismatch between assets and liabilities. The crisis of 2008 was so serious because it involved all three—big bets on structured products linked to the housing market, and bank-balance sheets that were both overstretched and dependent on short-term funding. The Asian crisis of the late 1990s was the result of companies borrowing too much in dollars when their revenues were in local currency. The dotcom bubble had less serious consequences than either of these because the concentrated bets were in equities; debt did not play a significant part.It may seem surprising to assert that the genesis of the next crisis is probably lurking in corporate debt. Profits have been growing strongly. Companies in the S&P 500 index are on target for a 25% annual gain once all the results for the first quarter are published. Some companies, like Apple, are rolling in cash.But plenty are not. In recent decades companies have sought to make their balance-sheets more “efficient” by raising debt and taking advantage of the tax deductibility of interest payments. Businesses with spare cash have tended to use it to buy back shares, either under pressure from activist investors or because doing so will boost the share price (and thus the value of executives’ options).At the same time, a prolonged period of low rates has made it very tempting to take on more debt. S&P, a credit-rating agency, says that as of 2017, 37% of global companies were highly indebted. That is five percentage points higher than the share in 2007, just before the financial crisis hit. By the same token, more private-equity deals are loading up on lots of debt than at any time since the crisis.One sign that the credit quality of the market has been deteriorating is that, globally, the median bond’s rating has dropped steadily since 1980, from A- to BBB-. The corporate-bond market is divided into investment grade (debt with a high credit rating) and speculative, or “junk”, bonds below that level. The dividing line is at the border between BBB- and BB+. So the median bond is now one notch above junk.Even within investment-grade debt, quality has gone down. According to PIMCO, a fund-management group, in America 48% of such bonds are now rated BBB, up from 25% in the 1990s. The companies that issue them are also more heavily indebted than they used to be. In 2000 the net leverage ratio for BBB issuers was 1.7. It is now 2.9.Investors are not demanding higher yields to compensate for the deteriorating quality of corporate debt; quite the reverse. In a recent speech during a conference at the London Business School, Alex Brazier, the director for financial stability at the Bank of England, compared the yield on corporate bonds with the risk-free rate (the market’s forecast for the path of official short-term rates). In Britain investors are demanding virtually no excess return on corporate bonds to reflect the issuer’s credit risk. In America the spread is at its lowest in 20 years. Just as low rates have encouraged companies to issue more debt, investors have been tempted to buy the bonds because of the poor returns available on cash.Mr Brazier also found that the cost of insuring against a bond issuer failing to repay, as measured by the credit-default-swap market, fell by 40% over the past two years. That makes it seem as if investors are less worried about corporate default. But a model looking at the way that banks assess the probability of default, compiled by Credit Benchmark, a data-analytics company, suggests that the risks have barely changed over that period.So investors are getting less reward for the same amount of risk. Combine this with the declining liquidity of the bond market (because banks have withdrawn from the market-making business) and you have the recipe for the next crisis. It may not happen this year, or even next. But there are already ominous signs.Matt King, a strategist at Citigroup, says that foreign purchases of American corporate debt have dried up in recent months, and the return on investment-grade debt so far this year has been -3.5%. He compares the markets with a game of musical chairs. As central banks withdraw monetary stimulus, they are taking seats away. Eventually someone will miss a seat and come down with a bump.

This past weekend, I attended a re-enactment of the Battle of Lexington, the battle that started the American Revolutionary War, in Massachusetts. The pleasure of being with children and grandchildren was my primary motive. But as I watched the superb re-enactment, an obvious question came to mind: Why did the Americans defeat the British, not just at Lexington but in the war itself? The British forces were better armed and better trained, and there were potentially far more of them. On a purely military basis, the British should have won, yet they didn’t.A phrase came to mind: asymmetry of interests. The concept of asymmetrical warfare has become commonplace in recent years. It refers to warfare in which different types of technology and tactics confront each other, like improvised explosive devices against armored brigades. Sometimes, the force with what appears to be inferior technology can compel the force with superior technology to withdraw. This is what we see in the American Revolution. We need to consider why.

For the Homeland

About 56,000 British troops were deployed at the height of the Revolutionary War, supplemented by 30,000 Hessian mercenaries in a kind of coalition. The Americans deployed about 80,000 regular and militia forces. The British forces were far better trained and, most important, had more and better artillery. The Hessians were professional soldiers. The Americans had a core of trained soldiers, but the militia troops were a mixed bag. During the war, 25,000 American troops died in battle or from disease compared to 24,000 British. The British losses were a fraction of the global British force, but for the Americans, this was 5 percent of the free white male population, according to the website Foxtrot Alpha‏.The British forces were united. The American population was divided. A little less than half of all Americans were committed to the revolution. A fifth were loyal to the British. Thus, both sides were fighting on a terrain in which substantial parts of the population opposed them. The British drew their supplies from Britain, while the Americans had to draw their logistics from the population – with some help from the French.When you look at the disparities, the losses and the disunity, the Americans should have lost. It is true that the final battle involved the French fleet, but the Americans stayed intact as a fighting force for eight years to reach that point. So even leaving the French out, the Americans were not defeated. And to keep fighting, the Americans had to absorb tremendous casualties without a decisive break in cohesion and morale.They were able to do it because of the asymmetry of interests. The Americans were fighting for their homeland. Defeat would subordinate the United States to British power for a long time. They had no interests that could compete with the interest to defeat the British. The British, on the other hand, were simultaneously engaged in a struggle with France for domination of Europe and control of the oceans, a contest that would lead to global empire. For the British, the American Revolution was not a matter of indifference, but neither was its outcome decisive in determining Britain’s place in the world.The British were prepared to deploy a substantial force in North America, but having done that, they went on with their nascent industrial revolution and their global concerns. The amount of time and casualties they could rationally devote to North America had to be seen in the context of broader interests. They could absorb casualties, but the war could not be an absolute imperative.

Absolute War

World War II is on the other end of the spectrum, a rare war in which all major powers had absolutes at stake. Britain, Germany, Japan, the Soviet Union and the United States all faced, or could face, existential consequences from the war. Their interests were symmetrical. It was therefore a war in which no effort was spared by anyone to avoid defeat and attain victory. In a sense, the war, once commenced, ceased to be political. It became a purely military conflict in which anything less than total military and industrial commitment would be irrational. There was precious little political maneuvering once the war got fully underway in 1941.For many Americans, the WWII model, which I will call “absolute war,” ought to be the model for fighting all wars. Instead, none of the U.S. wars since WWII have been absolute. As a result, since that time the U.S. has been unable to decisively defeat enemies that are militarily inferior. Korea resulted in stalemate. Vietnam resulted in stalemate, withdrawal and the defeat of America’s Vietnamese allies. The wars against jihadists have not resulted in a decisive, positive outcome for the United States. The only conflict since WWII in which the U.S. achieved its strategic goal was Desert Storm, where the Iraqi army was defeated in Kuwait. Many blame strategy or insufficient public support or a host of other reasons for this.There might be truth to all these reasons, but I think the fundamental reason was an asymmetry of interest between opposing forces. Consider Vietnam. Vietnam was on the periphery of American strategic interest. The U.S. was less concerned with Vietnam than with the consequences in the region and elsewhere if North Vietnam were to unite the country under communism. Those consequences were hypothetical – even if they occurred, they might not undermine U.S. interests substantially. On the other side, the North Vietnamese were fighting for fundamental national imperatives, chief among them the unification of Vietnam under the ideological and political control of Hanoi. From this, they might control all of Indochina and emerge as a major regional power able to counterbalance China.In other words, the outcome of the wars in Vietnam – French and American – went to the heart of the North Vietnamese national interest. The wars from the French and American points of view were not insignificant but were still on the margins of national imperatives. The unification of Vietnam under a communist regime was essential to North Vietnam. Blocking North Vietnam’s ambitions was of interest to the United States, but not an absolute imperative. It was part of a mosaic of interests.The British were not prepared to devote all the resources they had to fighting American rebels. Doing so would have been irrational. Even defeat at the hands of the heavily committed Americans was more palatable than throwing their fleet into battle with the French at that time and place. For the British, there was nothing absolute in North America. It was a political war, not an absolute one. The same has been true of the United States in Korea, Vietnam, Kuwait, Afghanistan and Iraq. Thus, only one of these wars was won, while over time, the imperative that led to war dissipated.When Great Powers ‘Lose’

In a democratic society, sacrificing lives without an absolute commitment to victory is unsavory. All of the wars since World War II have left a bad taste in the mouths of Americans. Sacrificing lives for tactical advantage, rather than for the direct defense of the homeland, is unpalatable. Sacrificing them for tactical advantage that is abandoned over time is worse. Absolute war is moral; political war designed to bring temporary advantage has the air of immorality.

In watching the re-enactment of Lexington, I could imagine British planners thinking, “We can’t abandon North America, but we can’t ignore the French, and the French are more important.” They must have spent many hours being briefed on the French and far less on the Americans. In due course, since the Americans were prepared to die far out of proportion to the interests of the British, their notional helicopters lifted off their notional embassies and left with their global power surging in spite of defeat.Great powers have multiple interests, and not all interests are the same. That means a global power is prepared to initiate and withdraw from wars without victory, for tactical and political advantage. Over time, paying the cost of the war becomes irrational. Great powers can “lose” wars in this sense and still see their power surge. Fighting in a war in which your country’s interest is not absolute, and therefore the lives of soldiers are not absolute, is difficult for a democracy to do. In most of the world, the great power will encounter an asymmetry of interest. Those who live there care far more about the outcome of the war than the great power does. And so, the great power withdraws from Syria when the price becomes higher than the prize. Given the string of defeats, it is expected that the great power is in decline. Like Britain after its defeat in North America, it is not in decline. It has simply moved on to more pressing interests.

European bank executives are facing the return of an all too familiar problem: political panic.After years of slowly healing from past crises, European banks have recently had the luxury of turning their focus to boosting profit and shedding bad loans. But the political turmoil in Italy—home to arguably Europe’s most problematic banking sector—has rekindled fears that the euro’s fragility, and authorities’ failure to unify the region’s disparate banking system, will continue to haunt the industry.As the political temperature rises in Rome, and to a lesser extent in Madrid, European banks have taken the brunt of the pain.The Euro Stoxx Banks index is down 5% this week following Italian President Sergio Mattarella’s move to block the formation of an antiestablishment government. A coming vote in Spain that could depose its pro-market center-right party from power has also rattled investors.“The whole banking sector was under attack,” said Vincenzo Longo, a strategist at IG Markets.If it continues, the uncertainty could delay widely anticipated interest rate rises in Europe, a move that would crimp bank profits. It could also hamper a closely watched cleanup operation at Italian lenders, analysts said.Italian banks have been at the heart of the selloff. The country’s chronically unprofitable lenders have been steadily wading through deep restructuring and shedding bad loans. Fragile investor confidence in the turnaround has been dented by the latest political upheaval.The negative sentiment also hit French and Spanish banks, which have sizable exposures to Italian government debt. In Portugal—which like Italy has a huge government debt pile—shares of Banco Comercial Português SA, the country’s largest traded bank, were down 12% this week.The headquarters of Italy’s Monte Dei Paschi di Siena. Italian banks have been at the heart of the selloff.

The headquarters of Italy’s Monte Dei Paschi di Siena. Italian banks have been at the heart of the selloff. Photo: Giuseppe Cacace/Agence France-Presse/Getty ImagesEuropean bank share prices stabilized in early trade Wednesday but the hit to investor confidence in the sector was palpable.This latest instability comes as the European banking sector continues to lick its wounds from the continent’s last debt crisis.A huge balance sheet clean up remains unfinished, with €813 billion ($938.3 billion) of bad loans—a large chunk of which is in Italy—still sitting on bank balance sheets, according to the European Banking Authority. Meanwhile, reforms aimed at decoupling the “doom loop” in which banks laden with their local government’s debt are sucked into a downward spiral as their home economy deteriorates remain unfinished.“Whatever is bad for the Italian economy is going to be bad for its banks,” said Sony Kapoor, managing director of think tank Re-Define. “That aspect of the loop you simply cannot break.”But the political turmoil reminds investors that European banks aren’t going to be making outsize profits soon.Up until the turn of the year investors had predicted that the combination of an economic rebound, banking reforms pushed through by the European Central Bank and rising interest rates would see European bank profits rise to €120 billion this year, says George Karamanos, an analyst at Keefe, Bruyette & Woods. “Are those expectations realistic now?” he asks, adding it is unlikely.That optimism was particularly visible in Italy. Up until a few months ago Italian banks were the best performing bank stocks in Europe. Political risk was seen as low and investors were cheering on a reduction in bad loans, which had shrunk to €285 billion from €350 billion in the space of a year. Politics has now dampened that optimism.In Italy, two antiestablishment parties, whose attempt to form a coalition government failed last Sunday, had struck an agreement on a joint government platform, which included a number of measures for the banking sector.The two parties planned to scrap a rule allowing banks to recover debts from retail borrowers without going through the courts, which could slow down the cleanup of banks’ balance sheets. They also hinted at the possible full nationalization of Banca Monte dei Paschi di Siena SpA, of which the government owns a majority stake after partially nationalizing it last year.While their coalition attempt collapsed, they could come back stronger if new elections are called. Talks in Italy continue on how to overcome the political impasse.That has raised questions over the future of the eurozone—both parties have flirted openly with the idea of pulling Italy out of the euro—and in turn spooked investors and highlighted a wider problem: EU authorities haven’t yet fully fixed the continent’s banking system.

A plan to package eurozone sovereign bonds together to reduce the riskiness of any individual bond within the pool, for example, has been largely shunned by Germany. The German government and other member states whose banks weren’t as hard-hit by the crisis, have also resisted the creation of an EU-wide deposit-insurance program, which would provide safety for depositors no matter their location. A Germany bank official said last week that EU-wide insurance program “probably won’t happen in my lifetime.”During the last eurozone crisis banks across Europe shed sovereign exposures to riskier periphery markets. However,​ domestic​ banks in those countries still have large exposure to their ​home sovereign debt, particularly as they are treated as safe assets under bank accounting rules. Currently 10 Italian banks have Italian sovereign debt holdings greater than their capital buffers, according to a study by France’s IESEG School of Management.After Italian banks, French banks are the second most exposed to Italian government debt with €44.27 billion in bonds, followed by Spain with €28 billion of sovereign debt, according to calculations by the EBA. France’s BNP Paribas SA, which has a large Italian bank, and Spain’s Banco de Sabadell SA are among the most exposed to Italy, analysts say.However, some analysts have played down the risk of another full blown eurozone crisis engulfing the region’s banks.“We do not expect a disorderly escalation of the situation into a repeat of the sovereign debt crisis,” analysts at UBS wrote in a recent note. Unlike years ago, the eurozone’s economy is growing and the ECB is still buying government and company bonds.“We aren’t getting any panicked calls,” said one banker at a big European lender. European banks have largely already tapped markets to raise their funding for the year, so the latest upheaval isn’t hitting balance sheets yet.Some investors are even eyeing deals again in Europe, said one major portfolio manager. “It’s starting to look cheap again,” he says.

Factors supporting the market no longer look so solid; rising U.S. Treasury yields and a stronger dollar pose risks

By Richard Barley

OFF THE BOILTotal return on emerging-market and developed-market stocks, in dollar terms

Source: FactSet

Good times can’t last forever. Last year, strong global growth and a weak dollar lit up emerging-market stock and bond returns. But the low-hanging fruit has been harvested. And now times are looking tough.After a strong start to 2018, emerging-market stocks have suffered, and the stronger dollar has hit bond returns. The JP Morgan GBI-EM local-currency bond index now up only 1.8%, versus 5% in January.

Factors supporting the market no longer look so solid. China’s unexpected cut in bank reserve ratios raises questions about whether the emerging world’s most important growth engine has hidden weaknesses. Capital Economics’ emerging growth tracker slowed to 4.4% in February from 4.6% at the end of 2017. The upgrade to global growth in the latest International Monetary Fund forecasts was down to higher forecasts for advanced economies, reducing the allure of higher growth in emerging nations.Meanwhile, rising U.S. Treasury yields and a stronger dollar pose risks. The ICE U.S. dollar index has risen 3.4% from its February low. Riskier high-yielding emerging-market currencies like the Brazilian real, Turkish lira and South African rand have fallen this year, and even low-yielding countries with better fundamentals have seen some reversal recently, notes BNP Paribas . That removes a tailwind that propelled emerging-market assets last year..After a strong start to 2018, emerging-market stocks have suffered, and the stronger dollar has hit bond returns. Photo: Reuters

Political risk is on the radar. Trade clashes between the U.S. and China raise questions about the process of globalization that has lifted growth in emerging markets; geopolitical tensions leading to sanctions on Russia have slammed the ruble. Elections are due in some important emerging nations, including Brazil, Mexico and Turkey, which make investors nervy.If the world economy is only going through a soft patch, then the potential returns afforded by some emerging-market assets, bonds especially, still look attractive. Emerging-market bonds offer higher yields than available elsewhere: the yield on the GBI-EM index is over 6%.

DOLLAR DAMPERCurrencies of high-yielding emerging countries have diverged from those of low-yielding countries against the dollar

Still, emerging-market investors have invested a lot of faith in the idea that many countries used recent leaner years to fix some of their problems, reducing current-account deficits and making themselves less vulnerable.That theory still makes sense. But with conditions less hospitable, it faces a bigger test. Expect more divergence among countries. A rougher patch lies ahead for emerging markets.

You wouldn’t know that by listening to current commentary on the economy.There is a bigger threat, though. But first, there is some clarification about inflation that is necessary.Most people infer rising prices when they hear the term inflation. That is not correct. The rising prices are the ‘effects’ of inflation. The inflation, itself, has already been created.It is not created, or caused, by companies raising prices. And it is not created by ‘escalating wage demand’.When someone says, “inflation is back”, they are referring to rising prices. Yet they are wrong on two counts. First, as we have previously said, the rising prices, generally, are the effects of inflation. Second, the inflation isn’t back; because it never went away.From my book Inflation, What It Is, What It Isn't, And Who's Responsible For It:“Inflation is the debasement of money by the government. There is only one cause of inflation: government. The term government also includes central banks; especially the U.S. Federal Reserve Bank.”The United States Federal Reserve Bank has left a century-long trail of damage in its wake. A misguided attempt to manage the stages (growth, prosperity, recession, depression) of the economic cycle has led to nearly complete destruction in the value of our money. The cumulative loss in value of the U.S. dollar since inception of the Fed in 1913 amounts to more than ninety-eight percent.The erosion in the value of the U.S. dollar is the result of inflation that has been created by the Fed via their expansion of the total supply of money and credit. The inflation created by the Fed is ongoing and intentional. So, it is difficult to not expect more of the same. But, in addition, they are now just as focused on ‘holding things together’.The Federal Reserve caused the Depression of the 1930s and worsened its effects. Their actions also led directly to the catastrophic events we experienced in 2007-08 and have made us more vulnerable than ever before to calamitous events which will set us back decades in our economic and financial progress. The new Chairman of the Federal Reserve, Jerome Powell, is personable, likable, candid, and direct. But he cannot and will not preside over any changes that will have lasting positive impact.The Federal Reserve does not act preemptively. They are restricted by necessity to a policy of containment and reaction regarding the negative, implosive effects of their own making.And their actions, especially including the inflation that they create, are damaging and destructive. Their purpose is not aligned with ours and never will be.Yet they are not independent. In fact, they have a very cozy relationship with the United States Treasury. That relationship is the reason they are allowed to continue to fail in their attempt to manage the economic cycle.There are two specific terms which describe our own actions and relationship with the Federal Reserve – obsession and dependency.We are bombarded daily with commentary and analysis regarding the Fed and their actions. Almost daily we are treated to rehashing of the same topics – interest rates, inflation – over and over. And we seemingly can’t read or hear enough, i.e. obsession.But are we reading or hearing anything which will help us gain a better understanding about the Federal Reserve? And what, if anything, can we realistically expect them to do?We are also hooked on the liberally provided drug of cheap credit. Our entire economy functions on credit. We are dependent on it. And without huge amounts of cheap credit, our financial and economic activity would come to a screeching halt.A credit implosion and a corresponding collapse of stock, bond and real estate markets would lead directly to deflation. The incredible slowdown in economic activity leads to severe effects which we refer to as a depression.Deflation is the exact opposite of inflation. It is the Fed’s biggest fear. And it is a bigger threat at this time than progressively more severe effects of inflation.The U.S. Treasury is dependent on the Federal Reserve to issue an ongoing supply of Treasury Bonds in order to fund its (the U.S. government’s) operations. During a deflation, the U.S. dollar undergoes an increase in its purchasing power, but there are fewer dollars in circulation.The environment during deflation and depression makes it difficult for continued issuance of U.S. Treasury debt, especially in such large amounts as currently. Hence, the resulting lack of available funds for the government can lead to a loss of control.The U.S. government is just as dependent on debt as our society at large.

The following excerpt is from my new book All Hail The Fed“When something finally does happen, the effects will be horribly worse. And avoidance of short-term pain will not be an option. The overwhelming cataclysm will leave us no choice.As severe as the effects will be because of previous avoidance and suppression, they will also last longer because of government action. The cry for leaders to “do something” will be loud and strong. And those in authority will oblige.But don’t look to the Federal Reserve for a resolution. They are the cause of the problem.”

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.